Annuity FAQ

What is an Annuity?

To put it simply, an annuity is a contract between an individual (called the annuity owner) and an insurance company for a guaranteed interest-bearing policy with guaranteed annuity income options.

What is a tax-deferred annuity?

It is a tax-advantaged product issued by an insurance company where long term financial needs can be solved better than with most other financial alternatives.

What is the major advantage of annuities?

All annuity dollars are able to accumulate interest completely tax deferred. This means an individual can delay taxation of growth until the money is needed and therefore earn triple interest — interest on the principal, interest on the interest and interest on the money that normally would be paid in taxes.

Who wants to own an annuity?

People who want a safe way to reduce taxes and those who want to decide when to pay taxes.

Is an annuity safe?

Yes — with annuities, your principal is 100% safe and you are guaranteed to earn at least a minimum interest rate. This guaranteed safety is possible because each insurance company issuing annuities is supervised and regulated by each state’s insurance department; plus, they are backed by a Legal Reserve System and a Guaranty Fund.

Is the annuity for everyone?

No. Dollars earmarked for short-term needs should not go into the annuity. In addition, at least six months of income should be saved for emergencies outside of the annuity. Also, those who need current income should consider an immediate annuity, not a deferred annuity. On the other hand, those looking for one of the safest ways “to accumulate” dollars on a tax-advantaged basis will find the deferred annuity extremely beneficial.

Who should consider purchasing an annuity?

Anyone who wants a safe way to accumulate funds through triple compounding without paying current taxes on earnings should definitely consider purchasing an annuity

Since a withdrawal of principal is tax-free and IRS penalty free, can principal be withdrawn first and then interest?

No, the IRS considers that interest earnings are withdrawn first. Naturally, any portion of a withdrawal exceeding interest earned would be a tax-free return on principal.

What kinds of dollars can be used to buy annuities?

Dollars from maturing CDs, money market funds, checking and savings accounts, mutual fund accounts, stocks and bond funds, IRA rollovers, etc. can all be used to purchase an annuity.

What if the annuity is paying an interest rate less than other financial alternatives?

You should first compare the value of the “no market risk” feature of the annuity to other alternatives you are considering. You then must remember that the interest on many alternatives is currently taxable every year. Also, Section 1035 of the Internal Revenue Code allows annuity owners to move their dollars from one annuity to another annuity income tax-free.

Will an annuity be tied up in probate proceedings?

No — as long as the owner designates a “named” beneficiary other than his or her estate, the beneficiary will receive the annuity dollars without the delay, expense and hassles of probate proceedings.

Will the beneficiary be taxed on the interest that has accumulated inside the annuity?

Yes, beneficiaries will be taxed on the tax-deferred interest when they receive those dollars. However, if a beneficiary is the spouse of the owner and the owner dies, he/she may elect to continue the annuity and postpone taxes. Once again, the client decides when to pay income taxes. If the beneficiary is not the spouse and the owner dies, then dollars must be totally withdrawn within five years or they may be received over the beneficiary’s life expectancy. However, this latter option must be elected during the first 12 months following the owner’s death.

Is an annuity identical to an IRA?

No. Although an annuity is often used as the funding vehicle for an IRA, many annuities are purchased with after-tax dollars that are not deductible. Also, with annuities, there are not government-imposed limits on how much an individual can contribute to an annuity.

Annuity Glossary

Accumulation period

The time prior to an annuity’s payout period when money builds up in the annuity contract.

Annuitant

The person whose life expectancy is used to determine the payout of an annuity.

Annuitize

Converting the value of an annuity contract into a stream of income payouts.

Annuity

A retirement product that allows you to save for your future on an income tax-deferred basis and then allows you to choose a payout option that best meets your need for income when you retire—lump sum, income for life, or income for a certain period of time.

Annuity Due

A contract in which annuity payments are made at the beginning of each payment period. The first payment is applied on the contract effective date.

Days Rate Held on Rollovers

If you rollover an existing annuity to a new annuity with a different insurance company, the new company will normally hold the rate for a period of time. If the money is not received from the old company within that period, the new annuity will receive the rate in effect on the date the money is received.

Deferred Annuity

A contract in which annuity payouts begin at a future date.

Effective Annual Yield

Most companies compound and credit interest daily. The rate shown is the effective annual yield after compounding the daily nominal rate. Some companies pay a first year bonus on their interest to encourage new business. The Effective Annual Yield (EAY) includes the bonus.

Rate Bonus

Some annuities pay a bonus on the base rate. For example, if the base rate is 6.00% and there is a 1.00% first year bonus, the EAY will be 7.00%.

Premium Bonus

Some annuities pay an upfront premium bonus. For example, if the base rate is 6.00% with a 1.00% premium bonus, 7.06% will be shown as the Effective Annual Yield.

Equity-Indexed Annuity

A variation of the fixed annuity. With this type of annuity, your account accumulates at a minimum fixed rate of return. Your account also may earn additional interest based on the performance of an equity index. Generally, the indices used are widely reported common stock indices, the most prevalent being the Standard & Poor’s 500 Composite Stock Price Index.

Fixed Annuity

An annuity contract in which the premiums you pay are credited with a fixed rate of return by the life insurance company, and the company guarantees a fixed payout every month.

Flexible-Premium Deferred Annuity

An annuity contract that permits varying the amount and frequency of premium payments from year to year for payouts that will occur in the future.

Immediate Annuity

A contract in which annuity payments are made at the end of each payment period. Payment periods may be monthly, quarterly, semi-annually, or annually.

Initial Rate Period

The period of time, usually listed in years, which the company agrees to pay the initial crediting rate.

Load

Any sales fees or charges you pay in purchasing an annuity contract.

Minimum Rate Guarantee after Initial Period

This minimum rate guarantee serves two purposes:

1. It provides a minimum interest rate a company may credit to an annuity after the initial rate period.

2. It is also the rate that insurance company actuaries use to calculate reserve requirements in order to meet state insurance laws.

Payout Period

The period during which you receive the income from your annuity contract.

Principal

The amount you pay into your annuity contract as distinguished from the earnings that are credited to it. May also be referred to as purchase payments or contributions.

Surrender Penalty

The penalty applied to any amount exceeding the Free Annual Withdrawal Amount or to multiple withdrawals within the same contract year if they are not allowed by the terms included in the contract. In some cases, if the entire annuity is surrendered, the penalty will be applied to the full value of the annuity.

Some annuities include a Market Value Adjustment (“MVA”) if surrendered.

1. If the contract rate is higher than current rates on new money, a positive MVA adjustment may be made in the cash value. Therefore, if rates go down after the purchase date, the penalty will be less than shown.

2. If the contract rate is lower than current rates on new money, a negative adjustment is made in the cash value. Therefore, if rates go up after the purchase date, the surrender penalty will be higher than shown.

--- Penalty Waived with Payout Over
Most companies waive the surrender penalty if the cash value is paid out over a period of time or annuitized, usually five years or longer.

--- Penalty Waived at the Death Of
Some annuities waive all surrender penalties in the event of death of the annuitant or some waive penalties at death of the owner. Some waive penalties at the death of owner or annuitant. Some annuities do not waive penalties at death of the owner or annuitant, unless a payout of five years or longer is elected.

--- Medical Waiver Bail-Out
In certain circumstances, such as total disability or nursing home confinement, part or the entire surrender penalty may be waived on some annuities.

--- Sales and Maintenance Fees
There are no front-end sales charges with most annuities. If $10,000 is deposited into an annuity, the full $10,000 will be earning interest.

Variable Annuity

A contract in which the premiums you pay are invested in bond and stock funds. Your selection of funds depends on the level of risk you want to assume. The account value reflects the performance of the funds you select. Over the long-term, variable annuities invested in equities generally reflect the growth and performance of the economy and can serve as a hedge against inflation.

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